Rotation into Small Cap Stocks
By: David I. Templeton, CFA, Principal & Chief Investment Officer
Author: David I. Templeton, CFA, Principal and Portfolio Manager
Over the course of the last six months I have written articles about our firm adding small company stock exposure to our client portfolios. The last article was in January and titled, Time For Small Caps?. These additions began in September of last year and another addition in January this year. As a firm we had been out of any small company stock exposure since 2013, which has been the correct decision as large cap stocks have significantly outperformed small caps since that time. Yesterday though a strong rotation took place out of mega cap stocks into smaller cap stocks.
This rotation is only a day, but one will see if follow through occurs in the days ahead? Time will tell. The significance of the rotation cannot be underestimated though. When looking at the Morningstar categories style box, small cap value stocks were up over 3% Thursday while large cap growth stocks were down -1.5%.
I wrote an article at the beginning of this week discussing the disparity in return between the group of mega cap, or so-called Mag 7 stocks, versus the rest of the market. The takeaway from the article was the fact concentration alone is not a reason for stock rotation; however, the magnitude in the difference in return between the mag 7 and the rest of the market is a viable reason.
Thursday was only one day, but the Mag 7 did not fare well with the MAGS ETF (MAGS) down almost -4.5%. A part of the driver of the performance swing has to do with the favorable report on consumer inflation. Again, this is only a day and the producer price inflation report is released Friday. This report could also lead to further rotation if the PPI figure is favorable. One reason for the positive equity reaction is the fact the market is now anticipating a rate cut by the Federal Reserve in September. The market thinking is a rate cut will stimulate the economy with small company stocks having the most leverage to a positively growing economy.
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